This risk management strategy can be a valuable form of price protection in the volatile world of farming.
By Ron Mortensen, Dairy Gross Margin, LLC
Last month, we discussed how Livestock Gross Margin for Dairy (LGM-Dairy) can be part of the conversation with a lender, as one of the different marketing strategies that can be used to reduce the risk in today’s world of volatile feed and milk prices.
First, here’s a review of the basics of purchasing an LGM-Dairy policy:
1. Sales are made one day per month, on the last business Friday of the month. Sales begin in the late afternoon/early evening.
2. The application is relatively easy.
3. The payment for the premium due is made at the end of the policy period.
A policy can be designed in many different ways. First, what months do you want to cover? Buying a policy for at least two months means you get a government premium subsidy. You can cover up to 10 months. Next, you can choose the deductible you want. Of course, the higher the deductible, the lower the premium. Finally, you can choose the amount of feed you wish to cover (you need to have some feed in the policy, but you can adjust it depending on your ration/crop condition, etc.). Use a University of Wisconsin website to help you choose the amount of feed coverage. Go to http://future.aae.wisc.edu/lgm_analyzer/
Consider using LGM-Dairy to insure milk out in the future, say the last three months that can be purchased. This is where the greatest level of uncertainty is regarding both milk and feed prices. So, on June 27, protect 15% of your milk production for March/April/May of 2015.
Remember how much flexibility is built into LGM-Dairy. A producer can "layer" or "stack" coverage. So, as the months go by, continue to purchase the last three months of coverage available. At the end of July, buy 15% for April/May/June of 2015. At the end of August, buy 15% for May/June/July of 2015. Eventually you will be covering 45% of your milk, and you will have a bundle of policies protecting your dairy’s financial position.
If LGM-Dairy becomes part of a risk management plan, what are some of the practical questions and considerations?
First may be the whole question of "do you really want to receive a check from the insurance company for a loss?" Receiving a payment on your LGM policy means margins (highly influenced by the price of milk) have collapsed. Yes, you have made money on your LGM policy, but your overall dairy operation is probably suffering.
An LGM policy is a form of insurance, and it is probably best if it does not pay off. No check from the insurance company means that margins are wider than what you insured and, as a result, your dairy is probably more profitable. Having said that, the LGM policy can be a valuable form of protection in the volatile world of farming nowadays.
One of the hardest wrinkles of this program to grasp is how to calculate gains and losses to come up with a net indemnity (a net payment on the policy). A gain or loss is calculated each month, but for policies that last multiple months (as most do), the gains and losses are added together to determine any potential payment. In a 10-month period, there could be five loss months and five gain months. These gains and losses offset, and there might not be a payment on the policy. The University of Wisconsin website (mentioned above - http://future.aae.wisc.edu/lgm_analyzer/) can help with these calculations.
If there is an insurance indemnity, what do you do? Provide your insurance agent with proof of production from your processor or cooperative for the amount of milk insured.
Ron Mortensen is principal of Dairy Gross Margin, LLC, an agency that specializes in LGM-Dairy products. Mortensen also is owner of Advantage Agricultural Strategies, Ltd., a commodity trading advisor. Reach him at firstname.lastname@example.org or visit www.dairygrossmargin.com.